By an overwhelming and bipartisan majority vote, the Rhode Island Legislature adopted sweeping pension reforms last month, at the urging of the governor and the state treasurer. Disappointed labor leaders are expected to seek redress in the courts. Their complaint is that, in violation of contract law, benefits will be frozen, modified and even reduced for incumbent employees and cost-of-living adjustments (COLAs) will be frozen for current retirees.

Rhode Island's state pension plan is a mess, with very serious underfunding. This legislation addresses that problem but leaves the dozens of municipal plans to fend for themselves. That's unfortunate, because many of those local systems are clearly in a death spiral financially. Nonetheless, the new pension law deserves national attention for four features:

  1. The new law invokes the "police power" of the state to take actions necessary to preserve the pension system. As drastic as its opponents may claim it to be, it leaves employees and retirees with a "reasonable benefit" (in my view), which is an essential feature to satisfy federal case precedents. There are other ways the new law was crafted to meet key tests that federal judges have used when evaluating federal contract law issues for public pensions. It takes steps to mitigate the adverse consequences on employees by re-amortizing the pension deficit over a longer period. It seeks to achieve changes that are the minimum necessary. The state can show that it has done what it can before cutting benefits. Future taxpayers will bear a burden for benefits to retirees who never served them, so the pain is clearly shared and not borne entirely by the plan participants. These components of the statute thus set the stage for changes to incumbent employees' pension benefits, which otherwise are typically protected as "contractual" in state and federal courts. (It is noteworthy that Rhode Island's constitution does not explicitly protect prospective pension benefits for incumbent employees as do several other states).
  2. COLAs will be suspended until such time as the plan's financial condition improves sufficiently, and will thereafter be subject to financial-sustainability tests. Similar provisions have been tested and upheld in court already in Colorado and Minnesota. Unfunded COLAs are an actuarial disaster, and often contribute to the pension deficit. Freezing them can significantly improve the actuarial prospects for the plan, although this measure by itself shifts most of the burden onto recent retirees who have the longest remaining life span with frozen benefits and little opportunity to make personal adjustments. Rhode Island's new law is more comprehensive, which should put this provision in a better light legally as it reflects a genuinely balanced burden-sharing approach. Unions have already taken the state to court over similar earlier efforts to freeze COLAs, and prevailed in the first round, so this provision is undoubtedly headed to the state supreme court, where the decision will become a landmark case.
  3. Retirement ages will be increased next summer for current employees, to align with Social Security which is age 67 for younger, recent hires. Those near retirement would be allowed to retire earlier with a reduced benefit. Similar measures have been invoked elsewhere, including Cincinnati, so there is precedent for this approach. I have previously discussed equitable ways to institute such changes where legally permissible in a prior column. Readers seeking to implement similar reforms in other states should consider carefully the transition provisions, in order to protect current employees' earned, vested benefits.
  4. Current employees' accrued pension benefits will essentially be frozen and they will hereafter participate in a new hybrid plan that consists of a lower (1 percent) multiplier pension and a sidecar defined-contribution benefit that looks vaguely like the federal employees' retirement plan. This plan will provide immediate cost savings for current service and perhaps more importantly, share investment risks more equitably between the employer and employees.

The new law won't fix the state pension fund's entire problem, so it is important that all stakeholders realize that this reform package is just the first major step in what will be a long, long journey back toward full funding. Necessary, but not necessarily sufficient, would be the best way to describe its ultimate fiscal impact. And as mentioned before, these provisions do not apply to local governments, as several municipal leaders complained that the hybrid plan's design could actually increase their costs or abridge labor contracts. Obviously the city and town councils will watch closely how this bill is viewed by the state's courts, and many will be tempted to defer actions until the court resolves the contract law issues. That's unfortunate, because many of the local pension plans need equivalent reforms just as desperately as the state.

Gov. Lincoln Chafee and State Treasurer Gina Raimondo deserve accolades for their leadership and perseverance to bring these reforms to the state Legislature and successfully convince lawmakers of their necessity. They have risked their political support from organized labor in a strong union state. Whatever flaws this new law may contain, it looks to me to be the best achievable legislative solution to a messy fiscal problem -- and an important, unavoidable step in the right direction. If other governors and state treasurers facing similar pension problems were equally persistent and skillful, the festering sores of public pension plans would begin to heal more quickly.

Rhode Island's new law will be watched closely by policymakers, pension reform advocates, employers and unions in other states, as it moves (hopefully quickly) through the state courts. As noted before, its structure appears to be well-crafted from a federal law perspective, as it comprehensively addresses most if not all the key tests that federal judges have used when evaluating federal contract law issues for public pensions. But these issues are also state-specific and the union thus can have two bites of the apple. I can't predict the judicial outcome, but I can safely predict that it will become a landmark case. Some commentators believe the state's approach reflects a trend toward more-aggressive solutions that are sorely needed and often unavoidable. Pension reformers elsewhere will also be encouraged by the legislative success, voting margins and plan-design precedents. Rhode Island has thus become a battleground state in the national debate over public pension reforms, and a legal laboratory for the "police power" of the state to remedy a failed system. But as the unforgettable Yogi Berra once said, "It ain't over till it's over."